Economics Basics

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Reading Material for Basic Economics
Overview
Economics is the social science that studies economic activity to gain an understanding of the
processes that govern the production, distribution and consumption of goods and services in an
exchange economy.
The term economics comes from the Ancient Greek (oikonomia, "management of a household,
administration") from ”house") and (nomos, "custom" or "law"), hence "rules of the house(hold
for good management)". 'Political economy' was the earlier name for the subject, but
economists in the late 19th century suggested "economics" as a shorter term for "economic
science" to establish itself as a separate discipline outside of political science and other social
sciences.
Economics focuses on the behavior and interactions of economic agents and how economies
work. Consistent with this focus, primary textbooks often distinguish between microeconomics
and macroeconomics. Microeconomics examines the behavior of basic elements in the economy,
including individual agents and markets, their interactions, and the outcomes of interactions.
Individual agents may include, for example, households, firms, buyers, and sellers.
Macroeconomics analyzes the entire economy (meaning aggregated production, consumption,
savings, and investment) and issues affecting it, including unemployment of resources (labor,
capital, and land), inflation, economic growth, and the public policies that address these issues
(monetary, fiscal, and other policies).
Other broad distinctions within economics include those between positive economics, describing
"what is," and normative economics, advocating "what ought to be"; between economic theory
and applied economics; between rational and behavioral economics; and between mainstream
economics (more "orthodox" and dealing with the "rationality-individualism-equilibrium nexus")
and heterodox economics (more "radical" and dealing with the "institutions-history-social
structure nexus").
Besides the traditional concern in production, distribution, and consumption in an economy,

economic analysis may be applied throughout society, as in business, finance, health care, and
government. Economic analyses may also be applied to such diverse subjects as crime,
education, the family, law, politics, religion, social institutions, war, and science; by considering
the economic aspects of these subjects. Education, for example, requires time, effort, and
expenses, plus the foregone income and experience, yet these losses can be weighed against
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future benefits education may bring to the agent or the economy. At the turn of the 21st
century, the expanding domain of economics in the social sciences has been described as
economic imperialism.
Basic Economics
Definitions
There are a variety of modern definitions of economics. Some of the differences may reflect
evolving views of the subject or different views among economists. Scottish philosopher Adam
Smith (1776) defined what was then called political economy as "an inquiry into the nature and
causes of the wealth of nations", in particular as:
“a branch of the science of a statesman or legislator [with the twofold objectives of providing] a
plentiful revenue or subsistence for the people ... [and] to supply the state or commonwealth
with a revenue for the public services.”
J.-B. Say (1803), distinguishing the subject from its public-policy uses, defines it as the science of
production, distribution, and consumption of wealth. On the satirical side, Thomas Carlyle (1849)
coined "the dismal science" as an epithet for classical economics, in this context, commonly
linked to the pessimistic analysis of Malthus(1798). John Stuart Mill (1844) defines the subject in
a social context as:
“The science which traces the laws of such of the phenomena of society as arise from the
combined operations of mankind for the production of wealth, in so far as those phenomena are
not modified by the pursuit of any other object.”
Alfred Marshall provides a still widely cited definition in his textbook Principles of
Economics (1890) that extends analysis beyond wealth and from the societal to
the microeconomic level:
“Economics is a study of man in the ordinary business of life. It enquires how he gets his
income and how he uses it. Thus, it is on the one side, the study of wealth and on the other
and more important side, a part of the study of man”.
Lionel Robbins (1932) developed implications of what has been termed "perhaps the most
commonly accepted current definition of the subject":
“Economics is a science which studies human behaviour as a relationship between ends and
scarce means which have alternative uses.”

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Robbins describes the definition as not classificatory in "pick[ing] out certain kinds of behavior"
but rather analytical in "focus[ing] attention on a particular aspect of behavior, the form
imposed by the influence of scarcity." He affirmed that previous economist have usually
centered their studies on the analysis of wealth: how wealth is created (production), distributed,
and consumed; and how wealth can grow. But he said that economics can be used to study
other things, such as war, that are outside its usual focus. This is because war has as the goal
wining it (as a sought after end), generates both cost and benefits; and, resources (human life
and other costs) are used to attain the goal. If the war is not winnable or if the expected costs
outweigh the benefits, the deciding actors (assuming they are rational) may never go to war (a
decision) but rather explore other alternatives. We cannot define economics as the science that
study wealth, war, crime, education, and any other field economic analysis can be applied to;
but, as the science that study a particular common aspect of each of those subjects (they all use
scarce resources to attain a sought after end).
Some subsequent comments criticized the definition as overly broad in failing to limit its
subject matter to analysis of markets. From the 1960s, however, such comments abated as the
economic theory of maximizing behavior and rational-choice modeling expanded the domain of
the subject to areas previously treated in other fields. There are other criticisms as well, such as
in scarcity not accounting for the macroeconomics of high unemployment.
Gary Becker, a contributor to the expansion of economics into new areas, describes the
approach he favors as "combin[ing the] assumptions of maximizing behavior, stable preferences,
and market equilibrium, used relentlessly and unflinchingly." One commentary characterizes the
remark as making economics an approach rather than a subject matter but with great
specificity as to the "choice process and the type of social interaction that [such] analysis
involves." The same source reviews a range of definitions included in principles of economics
textbooks and concludes that the lack of agreement need not affect the subject-matter that the
texts treat. Among economists more generally, it argues that a particular definition presented
may reflect the direction toward which the author believes economics is evolving, or should
evolve.
Markets
Microeconomicsexamines how entities, forming a market structure, interact within a market to

create a market system. These entities include private and public players with various
classifications, typically operating under scarcity of tradeable units and government regulation.

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The item traded may be a tangible product such as apples or a service such as repair services,
legal counsel, or entertainment.
In theory, in a free market the aggregates (sum of) of quantity demanded by buyers and
quantity supplied by sellers will be equal and reach economic equilibrium over time in reaction
to price changes; in practice, various issues may prevent equilibrium, and any equilibrium
reached may not necessarily morally equitable. For example, if the supply of healthcare services
is limited by external factors, the equilibrium price may be unaffordable for many who desire it
but cannot pay for it.
Various market structures exist. In perfectly competitive markets, no participants are large
enough to have the market power to set the price of a homogeneous product. In other words,
every participant is a "price taker" as no participant influences the price of a product. In the
real world, markets often experience imperfect competition.
Forms include monopoly (in which there is only one seller of a good), duopoly (in which there
are only two sellers of a good), oligopoly(in which there are few sellers of a good), monopolistic
competition (in which there are many sellers producing highly differentiated goods), monopsony
(in which there is only one buyer of a good), and oligopoly (in which there are few buyers of a
good). Unlike perfect competition, imperfect competition invariably means market power is
unequally distributed. Firms under imperfect competition have the potential to be "price
makers", which means that, by holding a disproportionately high share of market power, they
can influence the prices of their products.
Microeconomics studies individual markets by simplifying the economic system by assuming

that activity in the market being analyzed does not affect other markets. This method of
analysis is known as partial-equilibrium analysis (supply and demand). This method aggregates
(the sum of all activity) in only one market. General-equilibrium theory studies various markets
and their behaviour. It aggregates (the sum of all activity) across all markets. This method
studies both changes in markets and their interactions leading towards equilibrium
Production, cost, and efficiency
In microeconomics, production is the conversion of inputs into outputs. It is an economic

process that uses inputs to create a commodity or a service for exchange or direct use.
Production is a flow and thus a rate of output per period of time. Distinctions include such
production alternatives as for consumption (food, haircuts, etc.) vs. investment goods(new

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tractors, buildings, roads, etc.), public goods (national defense, small-pox vaccinations, etc.) or
private goods (new computers, bananas, etc.), and "guns" vs. "butter".
Opportunity cost refers to the economic cost of production: the value of the next best
opportunity foregone. Choices must be made between desirable yet mutually exclusive actions.
It has been described as expressing "the basic relationship between scarcity and choice." The
opportunity cost of an activity is an element in ensuring that scarce resources are used
efficiently, such that the cost is weighed against the value of that activity in deciding on more
or less of it. Opportunity costs are not restricted to monetary or financial costs but could be
measured by the real cost of output forgone, leisure, or anything else that provides the
alternative benefit (utility).
Inputs used in the production process include such primary factors of production as labour
services, capital (durable produced goods used in production, such as an existing factory), and
land (including natural resources). Other inputs may include intermediate goods used in
production of final goods, such as the steel in a new car.
Economic efficiency describes how well a system generates desired output with a given set of
inputs and available technology. Efficiency is improved if more output is generated without
changing inputs, or in other words, the amount of "waste" is reduced. A widely accepted
general standard is Pareto efficiency, which is reached when no further change can make
someone better off without making someone else worse off.
The production–possibility frontier (PPF) is an expository figure for representing scarcity, cost,
and efficiency. In the simplest case an economy can produce just two goods (say "guns" and
"butter"). The PPF is a table or graph (as at the right) showing the different quantity
combinations of the two goods producible with a given technology and total factor inputs,
which limit feasible total output. Each point on the curve shows potential total output for the
economy, which is the maximum feasible output of one good, given a feasible output quantity
of the other good.
Scarcity is represented in the figure by people being willing but unable in the aggregate to
consume beyond the PPF(such as at X) and by the negative slope of the curve. If production of
one good increases along the curve, production of the other good decreases, an inverse
relationship. This is because increasing output of one good requires transferring inputs to it
from production of the other good, decreasing the latter.
The slope of the curve at a point on it gives the trade-off between the two goods. It measures
what an additional unit of one good costs in units forgone of the other good, an example of a

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real opportunity cost. Thus, if one more Gun costs 100 units of butter, the opportunity cost of
one Gun is 100 Butter. Along the PPF, scarcity implies that choosing more of one good in the
aggregate entails doing with less of the other good. Still, in a market economy, movement along
the curve may indicate that the choice of the increased output is anticipated to be worth the
cost to the agents.
By construction, each point on the curve shows productive efficiency in maximizing output for
given total inputs. A point inside the curve (as at A), is feasible but represents production
inefficiency (wasteful use of inputs), in that output of one or both goods could increase by
moving in a northeast direction to a point on the curve. Examples cited of such inefficiency
include high unemployment during a business-cycle recessionor economic organization of a
country that discourages full use of resources. Being on the curve might still not fully
satisfy allocative efficiency (also called Pareto efficiency) if it does not produce a mix of goods
that consumers prefer over other points.
Much applied economics in public policy is concerned with determining how the efficiency of
an economy can be improved. Recognizing the reality of scarcity and then figuring out how to
organize society for the most efficient use of resources has been described as the "essence of
economics", where the subject "makes its unique contribution."
Specialization
Specialization is considered key to economic efficiency based on theoretical and empirical

considerations. Different individuals or nations may have different real opportunity costs of
production; say from differences in stocks of human capital per worker or capital/labour ratios.
According to theory, this may give a comparative advantage in production of goods that make
more intensive use of the relatively more abundant, thus relatively cheaper, input.
Even if one region has an absolute advantage as to the ratio of its outputs to inputs in every
type of output, it may still specialize in the output in which it has a comparative advantage and
thereby gain from trading with a region that lacks any absolute advantage but has a
comparative advantage in producing something else.
It has been observed that a high volume of trade occurs among regions even with access to a
similar technology and mix of factor inputs, including high-income countries. This has led to
investigation of economies of scale and agglomeration to explain specialization in similar but
differentiated product lines, to the overall benefit of respective trading parties or regions.[32]

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The general theory of specialization applies to trade among individuals, farms, manufacturers,
service providers, and economies. Among each of these production systems, there may be a
corresponding division of labour with different work groups specializing, or correspondingly
different types of capital equipment and differentiated land uses.
An example that combines features above is a country that specializes in the production of
high-tech knowledge products, as developed countries do, and trades with developing nations
for goods produced in factories where labour is relatively cheap and plentiful, resulting in
different in opportunity costs of production. More total output and utility thereby results from
specializing in production and trading than if each country produced its own high-tech and
low-tech products.
Theory and observation set out the conditions such that market prices of outputs and
productive inputs select an allocation of factor inputs by comparative advantage, so that
(relatively) low-cost inputs go to producing low-cost outputs. In the process, aggregate output
may increase as a by-product or by design. Such specialization of production creates
opportunities for gains from trade whereby resource owners benefit from trade in the sale of
one type of output for other, more highly valued goods. A measure of gains from trade is the
increased income levels that trade may facilitate.
Supply and demand
Prices and quantities have been described as the most directly observable attributes of goods
produced and exchanged in a market economy. The theory of supply and demand is an
organizing principle for explaining how prices coordinate the amounts produced and consumed.
In microeconomics, it applies to price and output determination for a market with perfect
competition, which includes the condition of no buyers or sellers large enough to have price-
setting power.
For a given market of a commodity, demand is the relation of the quantity that all buyers
would be prepared to purchase at each unit price of the good. Demand is often represented by
a table or a graph showing price and quantity demanded (as in the figure). Demand theory
describes individual consumers as rationally choosing the most preferred quantity of each good,
given income, prices, tastes, etc. A term for this is "constrained utility maximization" (with
income and wealth as the constraints on demand). Here, utility refers to the hypothesized
relation of each individual consumer for ranking different commodity bundles as more or less
preferred.

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The supply and demand model describes how prices vary as a result of a balance between
product availability and demand. The graph depicts an increase (that is, right-shift) in
demand from D1 to D2 along with the consequent increase in price and quantity required to
reach a new equilibrium point on the supply curve (S).
The law of demand states that, in general, price and quantity demanded in a given market are
inversely related. That is, the higher the price of a product, the less of it people would be
prepared to buy of it (other things unchanged). As the price of a commodity falls, consumers
move toward it from relatively more expensive goods (the substitution effect). In addition,
purchasing power from the price decline increases ability to buy (the income effect). Other
factors can change demand; for example an increase in income will shift the demand curve for
a normal good outward relative to the origin, as in the figure. All determinants are
predominantly taken as constant factors of demand and supply.
Supply is the relation between the price of a good and the quantity available for sale at that
price. It may be represented as a table or graph relating price and quantity supplied. Producers,
for example business firms, are hypothesized to be profit-maximizers, meaning that they
attempt to produce and supply the amount of goods that will bring them the highest profit.
Supply is typically represented as a directly proportional relation between price and quantity
supplied (other things unchanged).
That is, the higher the price at which the good can be sold, the more of it producers will
supply, as in the figure. The higher price makes it profitable to increase production. Just as on
the demand side, the position of the supply can shift, say from a change in the price of a
productive input or a technical improvement. The "Law of Supply" states that, in general, a rise
in price leads to an expansion in supply and a fall in price leads to a contraction in supply.
Here as well, the determinants of supply, such as price of substitutes, cost of production,
technology applied and various factors inputs of production are all taken to be constant for a
specific time period of evaluation of supply.
Market equilibrium occurs where quantity supplied equals quantity demanded, the intersection
of the supply and demand curves in the figure above. At a price below equilibrium, there is a
shortage of quantity supplied compared to quantity demanded. This is posited to bid the price
up. At a price above equilibrium, there is a surplus of quantity supplied compared to quantity
demanded. This pushes the price down. The model of supply and demand predicts that for
given supply and demand curves, price and quantity will stabilize at the price that makes
quantity supplied equal to quantity demanded. Similarly, demand-and-supply theory predicts a
new price-quantity combination from a shift in demand (as to the figure), or in supply.

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For a given quantity of a consumer good, the point on the demand curve indicates the value, or
marginal utility, to consumers for that unit. It measures what the consumer would be prepared
to pay for that unit.[37] The corresponding point on the supply curve measures marginal cost,
the increase in total cost to the supplier for the corresponding unit of the good. The price in
equilibrium is determined by supply and demand. In a perfectly competitive market, supply and
demand equate marginal cost and marginal utility at equilibrium.
On the supply side of the market, some factors of production are described as (relatively)
variable in the short run, which affects the cost of changing output levels. Their usage rates can
be changed easily, such as electrical power, raw-material inputs, and over-time and temp work.
Other inputs are relatively fixed, such as plant and equipment and key personnel. In the long
run, all inputs may be adjusted by management. These distinctions translate to differences in
the elasticity (responsiveness) of the supply curve in the short and long runs and corresponding
differences in the price-quantity change from a shift on the supply or demand side of the
market.
Marginalist theory, such as above, describes the consumers as attempting to reach most-
preferred positions, subject to income and wealth constraints while producers attempt to
maximize profits subject to their own constraints, including demand for goods produced,
technology, and the price of inputs. For the consumer, that point comes where marginal utility
of a good, net of price, reaches zero, leaving no net gain from further consumption increases.
Analogously, the producer compares marginal revenue (identical to price for the perfect
competitor) against the marginal cost of a good, with marginal profit the difference. At the
point where marginal profit reaches zero, further increases in production of the good stop. For
movement to market equilibrium and for changes in equilibrium, price and quantity also change
"at the margin": more-or-less of something, rather than necessarily all-or-nothing.
Other applications of demand and supply include the distribution of income among the factors
of production, including labour and capital, through factor markets. In a competitivelabour
market for example the quantity of labour employed and the price of labour (the wage rate)
depends on the demand for labour (from employers for production) and supply of labour (from
potential workers). Labour economics examines the interaction of workers and employers
through such markets to explain patterns and changes of wages and other labour income,
labour mobility, and (un)employment, productivity through human capital, and related public-
policy issues.
Demand-and-supply analysis is used to explain the behavior of perfectly competitive markets,

but as a standard of comparison it can be extended to any type of market. It can also be

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generalized to explain variables across the economy, for example, total output (estimated as real
GDP) and the general price level, as studied in macroeconomics. Tracing the qualitative and
quantitative effects of variables that change supply and demand, whether in the short or long
run, is a standard exercise in applied economics. Economic theory may also specify conditions
such that supply and demand through the market is an efficient mechanism for allocating
resources.
Firms
People frequently do not trade directly on markets. Instead, on the supply side, they may work
in and produce through firms. The most obvious kinds of firms are corporations ,partnerships
and trusts. According to Ronald Coase people begin to organise their production in firms when
the costs of doing business becomes lower than doing it on the market. Firms combine labour
and capital, and can achieve far greater economies of scale (when the average cost per unit
declines as more units are produced) than individual market trading.
In perfectly competitive markets studied in the theory of supply and demand, there are many
producers, none of which significantly influence price. Industrial organizationgeneralizes from
that special case to study the strategic behavior of firms that do have significant control of
price. It considers the structure of such markets and their interactions. Common market
structures studied besides perfect competition include monopolistic competition, various forms
of oligopoly, and monopoly.
Managerial economics applies microeconomic analysis to specific decisions in business firms or

other management units. It draws heavily from quantitative methods such asoperations research
and programming and from statistical methods such as regression analysis in the absence of
certainty and perfect knowledge. A unifying theme is the attempt to optimize business
decisions, including unit-cost minimization and profit maximization, given the firm's objectives
and constraints imposed by technology and market conditions.
Uncertainty and Game Theory
Uncertainty in economics is an unknown prospect of gain or loss, whether quantifiable as risk

or not. Without it, household behavior would be unaffected by uncertain employment and
income prospects, financial and capital markets would reduce to exchange of a single
instrument in each market period, and there would be no communications industry. Given its
different forms, there are various ways of representing uncertainty and modeling economic
agents' responses to it.

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Game theory is a branch of applied mathematics that considers strategic interactions between
agents, one kind of uncertainty. It provides a mathematical foundation of industrial
organization, discussed above, to model different types of firm behavior, for example in an
oligopolistic industry (few sellers), but equally applicable to wage negotiations, bargaining,
contract design, and any situation where individual agents are few enough to have perceptible
effects on each other. As a method heavily used in behavioral economics, it postulates that
agents choose strategies to maximize their payoffs, given the strategies of other agents with at
least partially conflicting interests.
In this, it generalizes maximization approaches developed to analyze market actors such as in

the supply and demand model and allows for incomplete information of actors. The field dates
from the 1944 classic Theory of Games and Economic Behavior by John von Neumann and Oskar
Morgenstern. It has significant applications seemingly outside of economics in such diverse
subjects as formulation of nuclear strategies, ethics, political science, and evolutionary biology.
Risk aversion may stimulate activity that in well-functioning markets smooths out risk and
communicates information about risk, as in markets for insurance, commodity futures contracts,
and financial instruments. Financial economics or simply finance describes the allocation of
financial resources. It also analyzes the pricing of financial instruments, the financial structure
of companies, the efficiency and fragility of financial markets, financial crises, and related
government policy or regulation.
Some market organizations may give rise to inefficiencies associated with uncertainty. Based on
George Akerlof's "Market for Lemons" article, the paradigm example is of a dodgy second-hand
car market. Customers without knowledge of whether a car is a "lemon" depress its price below
what a quality second-hand car would be. Information asymmetry arises here, if the seller has
more relevant information than the buyer but no incentive to disclose it. Related problems in
insurance are adverse selection, such that those at most risk are most likely to insure (say
reckless drivers), and moral hazard, such that insurance results in riskier behavior (say more
reckless driving).
Both problems may raise insurance costs and reduce efficiency in driving otherwise willing
transactors from the market ("incomplete markets"). Moreover, attempting to reduce one
problem, say adverse selection by mandating insurance, may add to another, say moral hazard.
Information economics, which studies such problems, has relevance in subjects such as
insurance, contract law, mechanism design, monetary economics, and health care. Applied
subjects include market and legal remedies to spread or reduce risk, such as warranties,

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government-mandated partial insurance, restructuring or bankruptcy law, inspection, and

regulation for quality and information disclosure.
Market Failure
The term "Market Failure" encompasses several problems which may undermine standard
economic assumptions. Although economists categories market failures differently, the following
categories emerge in the main texts.
Information asymmetries and incomplete markets may result in economic inefficiency but also a
possibility of improving efficiency through market, legal, and regulatory remedies, as discussed
above.
Natural monopoly, or the overlapping concepts of "practical" and "technical" monopoly, is an

extreme case of failure of competition as a restraint on producers. Extreme economies of scale
are one possible cause.
Public goods are goods which are undersupplied in a typical market. The defining features are
that people can consume public goods without having to pay for them and that more than one
person can consume the good at the same time.
Externalities occur where there are significant social costs or benefits from production or
consumption that are not reflected in market prices. For example, air pollution may generate a
negative externality, and education may generate a positive externality (less crime, etc.).
Governments often tax and otherwise restrict the sale of goods that have negative externalities
and subsidize or otherwise promote the purchase of goods that have positive externalities in an
effort to correct the price distortions caused by these externalities. Elementary demand-and-
supply theory predicts equilibrium but not the speed of adjustment for changes of equilibrium
due to a shift in demand or supply.
In many areas, some form of price stickiness is postulated to account for quantities, rather than
prices, adjusting in the short run to changes on the demand side or the supply side. This
includes standard analysis of the business cycle in macroeconomics. Analysis often revolves
around causes of such price stickiness and their implications for reaching a hypothesized long-
run equilibrium. Examples of such price stickiness in particular markets include wage rates in
labour markets and posted prices in markets deviating from perfect competition.
Some specialized fields of economics deal in market failure more than others. The economics of
the public sector is one example. Much environmental economics concerns externalities or
"public bads".

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Policy options include regulations that reflect cost-benefit analysis or market solutions that
change incentives, such as emission fees or redefinition of property rights.
Public Sector
Public finance is the field of economics that deals with budgeting the revenues and
expenditures of a public sector entity, usually government. The subject addresses such matters
as tax incidence (who really pays a particular tax), cost-benefit analysis of government
programs, effects on economic efficiency and income distribution of different kinds of spending
and taxes, and fiscal politics. The latter, an aspect of public choice theory, models public-sector
behavior analogously to microeconomics, involving interactions of self-interested voters,
politicians, and bureaucrats.
Much of economics is positive, seeking to describe and predict economic phenomena. Normative
economics seeks to identify what economies ought to be like.
Welfare economics is a normative branch of economics that uses microeconomic techniques to

simultaneously determine the allocative efficiency within an economy and the income
distribution associated with it. It attempts to measure social welfare by examining the economic
activities of the individuals that comprise society.
Macro Economics
Macroeconomics examines the economy as a whole to explain broad aggregates and their
interactions "top down", that is, using a simplified form of general-equilibrium theory. Such
aggregates include national income and output, the unemployment rate, and price inflation and
sub aggregates like total consumption and investment spending and their components. It also
studies effects of monetary policy and fiscal policy.
The circulation of money in an economy in a macroeconomic model.
Since at least the 1960s, macroeconomics has been characterized by further integration as to
micro-based modeling of sectors, including rationality of players, efficient use of market
information, and imperfect competition. This has addressed a long-standing concern about
inconsistent developments of the same subject.
Macroeconomic analysis also considers factors affecting the long-term level and growth of
national income. Such factors include capital accumulation, technological change and labour
force growth.

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Microeconomics
Microeconomics (from Greek prefix mikro- meaning "small" and economics) is a branch of
economics that studies the behavior of individuals and small impacting players in making
decisions on the allocation of limited resources (see scarcity). Typically, it applies to markets
where goods or services are bought and sold. Microeconomics examines how these decisions and
behaviors affect the supply and demand for goods and services, which determines prices, and
how prices, in turn, determine the quantity supplied and quantity demanded of goods and
services.
This is in contrast to macroeconomics, which involves the "sum total of economic activity,
dealing with the issues of growth, inflation, and unemployment." Microeconomics also deals
with the effects of national economic policies (such as changing taxation levels) on the
aforementioned aspects of the economy. Particularly in the wake of the Lucas critique, much of
modern macroeconomic theory has been built upon 'micro foundations'—i.e. based upon basic
assumptions about micro-level behavior.
One of the goals of microeconomics is to analyze market mechanisms that establish relative
prices amongst goods and services and allocation of limited resources amongst many alternative
uses. Microeconomics analyzes market failure, where markets fail to produce efficient results,
and describes the theoretical conditions needed for perfect competition. Significant fields of
study in microeconomics include general equilibrium, markets under asymmetric information,
choice under uncertainty and economic applications of game theory. Also considered is the
elasticity of products within the market system.
Growth
Growth economics studies factors that explain economic growth – the increase in output per
capita of a country over a long period of time. The same factors are used to explain differences
in the level of output per capita between countries, in particular why some countries grow
faster than others, and whether countries converge at the same rates of growth.
Much-studied factors include the rate of investment, population growth, and technological
change. These are represented in theoretical and empirical forms (as in the neoclassical and
endogenous growth models) and in growth accounting.

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Business Cycle
The economics of a depression were the spur for the creation of "macroeconomics" as a
separate discipline field of study. During the Great Depression of the 1930s, John Maynard
Keynes authored a book entitled The General Theory of Employment, Interest and Money
outlining the key theories of Keynesian economics. Keynes contended that aggregate demand for
goods might be insufficient during economic downturns, leading to unnecessarily high
unemployment and losses of potential output.
He therefore advocated active policy responses by the public sector, including monetary policy
actions by the central bank and fiscal policy actions by the government to stabilize output over
the business cycle. Thus, a central conclusion of Keynesian economics is that, in some
situations, no strong automatic mechanism moves output and employment towards full
employment levels. John Hicks' IS/LM model has been the most influential interpretation of The
General Theory.
Over the years, understanding of the business cycle has branched into various research
programs, mostly related to or distinct from Keynesianism. The neoclassical synthesis refers to
the reconciliation of Keynesian economics with neoclassical economics, stating that
Keynesianism is correct in the short run but qualified by neoclassical-like considerations in the
intermediate and long run.
New classical macroeconomics, as distinct from the Keynesian view of the business cycle, posits
market clearing with imperfect information. It includes Friedman's permanent income
hypothesis on consumption and "rational expectations" theory, lead by Robert Lucas, and real
business cycle theory.
In contrast, the new Keynesian approach retains the rational expectations assumption; however
it assumes a variety of market failures. In particular, New Keynesians assume prices and wages
are "sticky", which means they do not adjust instantaneously to changes in economic
conditions.
Thus, the new classical assume that prices and wages adjust automatically to attain full
employment, whereas the new Keynesians see full employment as being automatically achieved
only in the long run, and hence government and central-bank policies are needed because the
"long run" may be very long.

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Unemployment
The amount of unemployment in an economy is measured by the unemployment rate, the

percentage of workers without jobs in the labour force. The labour force only includes workers
actively looking for jobs. People who are retired, pursuing education, or discouraged from
seeking work by a lack of job prospects are excluded from the labor force. Unemployment can
be generally broken down into several types that are related to different causes.
Classical models of unemployment occurs when wages are too high for employers to be willing
to hire more workers. Wages may be too high because of minimum wage laws or union activity.
Consistent with classical unemployment, frictional unemployment occurs when appropriate job
vacancies exist for a worker, but the length of time needed to search for and find the job leads
to a period of unemployment.
Structural unemployment covers a variety of possible causes of unemployment including a

mismatch between workers' skills and the skills required for open jobs. Large amounts of
structural unemployment can occur when an economy is transitioning industries and workers
find their previous set of skills are no longer in demand. Structural unemployment is similar to
frictional unemployment since both reflect the problem of matching workers with job vacancies,
but structural unemployment covers the time needed to acquire new skills not just the short
term search process.
While some types of unemployment may occur regardless of the condition of the economy,
cyclical unemployment occurs when growth stagnates. Okun's law represents the empirical
relationship between unemployment and economic growth. The original version of Okun's law
states that a 3% increase in output would lead to a 1% decrease in unemployment.nflation and
Monetary Policy
Money is a means of final payment for goods in most price system economies and the unit of
account in which prices are typically stated. A very apt statement by Professor Walker, a well-
known economist is that, " Money is what money does". Money has a general acceptability, a
relative consistency in value, divisibility, durability, portability, elastic in supply and survives
with mass public confidence. It includes currency held by the nonbank public and checkable
deposits. It has been described as a social convention, like language, useful to one largely
because it is useful to others.
As a medium of exchange, money facilitates trade. It is essentially a measure of value and more
importantly, a store of value being a basis for credit creation. Its economic function can be

17
contrasted with barter (non-monetary exchange). Given a diverse array of produced goods and
specialized producers, barter may entail a hard-to-locate double coincidence of wants as to what
is exchanged, say apples and a book. Money can reduce the transaction cost of exchange
because of its ready acceptability. Then it is less costly for the seller to accept money in
exchange, rather than what the buyer produces.
At the level of an economy, theory and evidence are consistent with a positive relationship
running from the total money supply to the nominal value of total output and to the general
price level. For this reason, management of the money supply is a key aspect of monetary
policy.
Fiscal Policy
Governments implement fiscal policy by adjusting spending and taxation policies to alter
aggregate demand. When aggregate demand falls below the potential output of the economy,
there is an output gap where some productive capacity is left unemployed. Governments
increase spending and cut taxes to boost aggregate demand. Resources that have been idled can
be used by the government.
For example, unemployed home builders can be hired to expand highways. Tax cuts allow
consumers to increase their spending, which boosts aggregate demand. Both tax cuts and
spending have multiplier effects where the initial increase in demand from the policy percolates
through the economy and generates additional economic activity.
The effects of fiscal policy can be limited by crowding out. When there is no output gap, the
economy is producing at full capacity and there are no excess productive resources. If the
government increases spending in this situation, the government use resources that otherwise
would have been used by the private sector, so there is no increase in overall output. Some
economists think that crowding out is always an issue while others do not think it is a major
issue when output is depressed.
Skeptics of fiscal policy also make the argument of Ricardian equivalence. They argue that an
increase in debt will have to be paid for with future tax increases, which will cause people to
reduce their consumption and save money to pay for the future tax increase. Under Ricardian
equivalence, any boost in demand from fiscal policy will be offset by the increased savings rate
intended to pay for future higher taxes.

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International Economics
International trade studies determinants of goods-and-services flows across international

boundaries. It also concerns the size and distribution of gains from trade. Policy applications
include estimating the effects of changing tariff rates and trade quotas. International finance is
a macroeconomic field which examines the flow of capital across international borders, and the
effects of these movements on exchange rates. Increased trade in goods, services and capital
between countries is a major effect of contemporary globalization.
The distinct field of development economics examines economic aspects of the economic
development process in relatively low-income countries focusing on structural change, poverty,
and economic growth. Approaches in development economics frequently incorporate social and
political factors.
Economic systems is the branch of economics that studies the methods and institutions by
which societies determine the ownership, direction, and allocation of economic resources. An
economic system of a society is the unit of analysis.
Among contemporary systems at different ends of the organizational spectrum are socialist
systems and capitalist systems, in which most production occurs in respectively state-run and
private enterprises. In between are mixed economies. A common element is the interaction of
economic and political influences, broadly described as political economy. Comparative economic
systems studies the relative performance and behavior of different economies or systems.
Gross domestic product (GDP)
Gross domestic product (GDP) is the market value of all officially recognized final goods and
services produced within a country in a year, or over a given period of time. GDP per capita is
often used as an indicator of a country's material standard of living.
GDP per capita is not a measure of personal income (See Standard of living and GDP). Under
economic theory, GDP per capita exactly equals gross domestic income (GDI) per capita.
However, due to differences in measurement, there is usually a statistical discrepancy between
the two figures.
GDP is related to national accounts, a subject in macroeconomics. GDP is not to be confused

with gross national product (GNP) which allocates production based on ownership.

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Theory
Mainstream economic theory relies upon a priori quantitative economic models, which employ a
variety of concepts. Theory typically proceeds with an assumption of ceteris paribus, which
means holding constant explanatory variables other than the one under consideration. When
creating theories, the objective is to find ones which are at least as simple in information
requirements, more precise in predictions, and more fruitful in generating additional research
than prior theories.
In microeconomics, principal concepts include supply and demand, marginalism, rational choice
theory, opportunity cost, budget constraints, utility, and the theory of the firm. Early
macroeconomic models focused on modeling the relationships between aggregate variables, but
as the relationships appeared to change over time macroeconomists, including new Keynesians,
reformulated their models in microfoundations.
The aforementioned microeconomic concepts play a major part in macroeconomic models – for
instance, in monetary theory, the quantity theory of money predicts that increases in the
money supply increase inflation, and inflation is assumed to be influenced by rational
expectations. In development economics, slower growth in developed nations has been
sometimes predicted because of the declining marginal returns of investment and capital, and
this has been observed in the Four Asian Tigers. Sometimes an economic hypothesis is only
qualitative, not quantitative.
Expositions of economic reasoning often use two-dimensional graphs to illustrate theoretical

relationships. At a higher level of generality, Paul Samuelson's treatise Foundations of Economic
Analysis (1947) used mathematical methods to represent the theory, particularly as to
maximizing behavioral relations of agents reaching equilibrium. The book focused on examining
the class of statements called operationally meaningful theorems in economics, which are
theorems that can conceivably be refuted by empirical data.
Empirical Investigation
Economic theories are frequently tested empirically, largely through the use of econometrics
using economic data. The controlled experiments common to the physical sciences are difficult
and uncommon in economics, and instead broad data is observationally studied; this type of
testing is typically regarded as less rigorous than controlled experimentation, and the
conclusions typically more tentative. However, the field of experimental economics is growing,
and increasing use is being made of natural experiments.

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Statistical methods such as regression analysis are common. Practitioners use such methods to
estimate the size, economic significance, and statistical significance ("signal strength") of the
hypothesized relation(s) and to adjust for noise from other variables. By such means, a
hypothesis may gain acceptance, although in a probabilistic, rather than certain, sense.
Acceptance is dependent upon the falsifiable hypothesis surviving tests. Use of commonly
accepted methods need not produce a final conclusion or even a consensus on a particular
question, given different tests, data sets, and prior beliefs.
Criticism based on professional standards and non-replicability of results serve as further checks
against bias, errors, and over-generalization, although much economic research has been
accused of being non-replicable, and prestigious journals have been accused of not facilitating
replication through the provision of the code and data. Like theories, uses of test statistics are
themselves open to critical analysis, although critical commentary on papers in economics in
prestigious journals such as the American Economic Review has declined precipitously in the
past 40 years. This has been attributed to journals' incentives to maximize citations in order to
rank higher on the Social Science Citation Index (SSCI).
In applied economics, input-output models employing linear programming methods are quite
common. Large amounts of data are run through computer programs to analyze the impact of
certain policies; IMPLAN is one well-known example.
Experimental economics has promoted the use of scientifically controlled experiments. This has
reduced long-noted distinction of economics from natural sciences allowed direct tests of what
were previously taken as axioms. In some cases these have found that the axioms are not
entirely correct; for example, the ultimatum game has revealed that people reject unequal
offers.
In behavioral economics, psychologist Daniel Kahneman won the Nobel Prize in economics in
2002 for his and Amos Tversky's empirical discovery of several cognitive biases and heuristics.
Similar empirical testing occurs in neuroeconomics. Another example is the assumption of
narrowly selfish preferences versus a model that tests for selfish, altruistic, and cooperative
preferences. These techniques have led some to argue that economics is a "genuine science."
Profession
The professionalization of economics, reflected in the growth of graduate programs on the

subject, has been described as "the main change in economics since around 1900".Most major

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universities and many colleges have a major, school, or department in which academic degrees
are awarded in the subject, whether in the liberal arts, business, or for professional study.
In the private sector, professional economists are employed as consultants and in industry,
including banking and finance. Economists also work for various government departments and
agencies, for example, the national Treasury, Central Bank or Bureau of Statistics.
The Nobel Memorial Prize in Economic Sciences (commonly known as the Nobel Prize in
Economics) is a prize awarded to economists each year for outstanding intellectual contributions
in the field.
Related Subjects
Economics is one social science among several and has fields bordering on other areas,
including Economic Geography, Economic History, Public Choice, Energy Economics, Cultural
Economics, Family Economics and Institutional Economics.
Law and Economics, or Economic analysis of Law, is an approach to legal theory that applies
methods of economics to law. It includes the use of economic concepts to explain the effects of
legal rules, to assess which legal rules are economically efficient, and to predict what the legal
rules will be. A seminal article by Ronald Coase published in 1961 suggested that well-defined
property rights could overcome the problems of externalities.
Political Economy is the interdisciplinary study that combines economics, law, and political
science in explaining how political institutions, the political environment, and the economic
system (capitalist, socialist, mixed) influence each other. It studies questions such as how
monopoly, rent-seeking behavior, and externalities should impact government policy. Historians
have employed political economy to explore the ways in the past that persons and groups with
common economic interests have used politics to effect changes beneficial to their interests.
Energy Economics is a broad scientific subject area which includes topics related to energy
supply and energy demand. Georgescu-Roegen reintroduced the concept of entropyin relation to
economics and energy from thermodynamics, as distinguished from what he viewed as the
mechanistic foundation of neoclassical economics drawn from Newtonian physics. His work
contributed significantly to thermoeconomics and to ecological economics. He also did
foundational work which later developed into evolutionary economics.
The sociological subfield of economic sociology arose, primarily through the work of Émile
Durkheim, Max Weber and Georg Simmel, as an approach to analysing the effects of economic
phenomena in relation to the overarching social paradigm (i.e. modernity). Classic works include

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Max Weber's The Protestant Ethic and the Spirit of Capitalism(1905) and Georg Simmel's The
Philosophy of Money (1900). More recently, the works of Mark Granovetter, Peter Hedstrom and
Richard Swedberg have been influential in this field.
History of Economic Thought
Economic writings date from earlier Mesopotamian, Greek, Roman, Indian subcontinent, Chinese,
Persian, and Arab civilizations. Notable writers from antiquity through to the 14th century
include Aristotle, Xenophon, Chanakya (also known as Kautilya), Qin Shi Huang, Thomas
Aquinas, and Ibn Khaldun. The works of Aristotle had a profound influence on Aquinas, who in
turn influenced the late scholastics of the 14th to 17th centuries. Joseph Schumpeter described
the latter as "coming nearer than any other group to being the 'founders' of scientific
economics" as to monetary, interest, and value theory within a natural-law perspective.
Two groups, later called "mercantilists" and "physiocrats", more directly influenced the
subsequent development of the subject. Both groups were associated with the rise of economic
nationalism and modern capitalism in Europe. Mercantilism was an economic doctrine that
flourished from the 16th to 18th century in a prolific pamphlet literature, whether of merchants
or statesmen. It held that a nation's wealth depended on its accumulation of gold and silver.
Nations without access to mines could obtain gold and silver from trade only by selling goods
abroad and restricting imports other than of gold and silver. The doctrine called for importing
cheap raw materials to be used in manufacturing goods, which could be exported, and for state
regulation to impose protective tariffs on foreign manufactured goods and prohibit
manufacturing in the colonies.
Physiocrats, a group of 18th century French thinkers and writers, developed the idea of the
economy as a circular flow of income and output. Physiocrats believed that only agricultural
production generated a clear surplus over cost, so that agriculture was the basis of all wealth.
Thus, they opposed the mercantilist policy of promoting manufacturing and trade at the
expense of agriculture, including import tariffs. Physiocrats advocated replacing administratively
costly tax collections with a single tax on income of land owners. In reaction against copious
mercantilist trade regulations, the physiocrats advocated a policy of laissez-faire, which called
for minimal government intervention in the economy.
Modern economic analysis is customarily said to have begun with Adam Smith (1723–1790).
Smith was harshly critical of the mercantilists but described the physiocratic system "with all
its imperfections" as "perhaps the purest approximation to the truth that has yet been
published" on the subject.

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Classical Political Economy
The publication of Adam Smith's The Wealth of Nations in 1776, has been described as "the
effective birth of economics as a separate discipline." The book identified land, labor, and
capital as the three factors of production and the major contributors to a nation's wealth, as
distinct from the Physiocratic idea that only agriculture was productive.
The publication of Adam Smith's The Wealth of Nations in 1776 is considered to be the first
formalisation of economic thought.
Smith discusses potential benefits of specialization by division of labour, including increased

labour productivity and gains from trade, whether between town and country or across
countries. His "theorem" that "the division of labor is limited by the extent of the market" has
been described as the "core of a theory of the functions of firm and industry" and a
"fundamental principle of economic organization." To Smith has also been ascribed "the most
important substantive proposition in all of economics" and foundation of resource-allocation
theory – that, under competition, resource owners (of labour, land, and capital) seek their most
profitable uses, resulting in an equal rate of return for all uses in equilibrium (adjusted for
apparent differences arising from such factors as training and unemployment).
In an argument that includes "one of the most famous passages in all economics," Smith
represents every individual as trying to employ any capital they might command for their own
advantage, not that of the society, and for the sake of profit, which is necessary at some level
for employing capital in domestic industry, and positively related to the value of produce. In
this:
He generally, indeed, neither intends to promote the public interest, nor knows how much he is
promoting it. By preferring the support of domestic to that of foreign industry, he intends only
his own security; and by directing that industry in such a manner as its produce may be of the
greatest value, he intends only his own gain, and he is in this, as in many other cases, led by
an invisible hand to promote an end which was no part of his intention. Nor is it always the
worse for the society that it was no part of it. By pursuing his own interest he frequently
promotes that of the society more effectually than when he really intends to promote it.
Economists have linked Smith's invisible-hand concept to his concern for the common man and
woman through economic growth and development, enabling higher levels of consumption,
which Smith describes as "the sole end and purpose of all production." He embeds the "invisible
hand" in a framework that includes limiting restrictions on competition and foreign trade by

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government and industry in the same chapter and elsewhere regulation of banking and the
interest rate, provision of a "natural system of liberty" — national defense, an egalitarian justice
and legal system, and certain institutions and public works with general benefits to the whole
society that might otherwise be unprofitable to produce, such as education and roads, canals,
and the like. An influential introductory textbook includes parallel discussion and this
assessment: "Above all, it is Adam Smith's vision of a self-regulating invisible hand that is his
enduring contribution to modern economics."
The Rev. Thomas Robert Malthus (1798) used the idea of diminishing returns to explain low
living standards. Human population, he argued, tended to increase geometrically, outstripping
the production of food, which increased arithmetically. The force of a rapidly growing
population against a limited amount of land meant diminishing returns to labour. The result, he
claimed, was chronically low wages, which prevented the standard of living for most of the
population from rising above the subsistence level. Economist Julian Lincoln Simon has criticized
Malthus's conclusions.
While Adam Smith emphasized the production of income, David Ricardo (1817) focused on the
distribution of income among landowners, workers, and capitalists. Ricardo saw an inherent
conflict between landowners on the one hand and labour and capital on the other. He posited
that the growth of population and capital, pressing against a fixed supply of land, pushes up
rents and holds down wages and profits. Ricardo was the first to state and prove the principle
of comparative advantage, according to which each country should specialize in producing and
exporting goods in that it has a lower relative cost of production, rather relying only on its
own production. It has been termed a "fundamental analytical explanation" for gains from
trade.
Coming at the end of the Classical tradition, John Stuart Mill (1848) parted company with the
earlier classical economists on the inevitability of the distribution of income produced by the
market system. Mill pointed to a distinct difference between the market's two roles: allocation
of resources and distribution of income. The market might be efficient in allocating resources
but not in distributing income, he wrote, making it necessary for society to intervene.
Value theory was important in classical theory. Smith wrote that the "real price of everything is
the toil and trouble of acquiring it" as influenced by its scarcity. Smith maintained that, with
rent and profit, other costs besides wages also enter the price of a commodity. Other classical
economists presented variations on Smith, termed the 'labour theory of value'. Classical
economics focused on the tendency of markets to move to long-run equilibrium.

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Marxist (later, Marxian) economics descends from classical economics. It derives from the work
of Karl Marx. The first volume of Marx's major work, Das Kapital, was published in German in
1867. In it, Marx focused on the labour theory of value and the theory of surplus value which,
he believed, explained the exploitation of labour by capital. The labour theory of value held that
the value of an exchanged commodity was determined by the labour that went into its
production and the theory of surplus value demonstrated how the workers only got paid a
proportion of the value their work had created. The U.S. Export-Import Bank defines a Marxist-
Lenninist state as having a centrally planned economy. They are now rare, examples can still be
seen in Cuba, North Korea and Laos.Neoclassical Economics
A body of theory later termed "neoclassical economics" or "marginalism" formed from about
1870 to 1910. The term "economics" was popularized by such neoclassical economists as Alfred
Marshall as a concise synonym for 'economic science' and a substitute for the earlier "political
economy". This corresponded to the influence on the subject of mathematical methods used in
the natural sciences.
Neoclassical economics systematized supply and demand as joint determinants of price and
quantity in market equilibrium, affecting both the allocation of output and the distribution of
income. It dispensed with the labour theory of value inherited from classical economics in favor
of amarginal utility theory of value on the demand side and a more general theory of costs on
the supply side. In the 20th century, neoclassical theorists moved away from an earlier notion
suggesting that total utility for a society could be measured in favor of ordinal utility, which
hypothesizes merely behavior-based relations across persons.
In microeconomics, neoclassical economics represents incentives and costs as playing a

pervasive role in shaping decision making. An immediate example of this is the consumer
theory of individual demand, which isolates how prices (as costs) and income affect quantity
demanded. In macroeconomics it is reflected in an early and lasting neoclassical synthesis with
Keynesian macroeconomics.
Neoclassical economics is occasionally referred as orthodox economics whether by its critics or

sympathizers. Modern mainstream economics builds on neoclassical economics but with many
refinements that either supplement or generalize earlier analysis, such as econometrics, game
theory, analysis of market failure and imperfect competition, and the neoclassical model of
economic growth for analyzing long-run variables affecting national income.
Neoclassical economics studies the behavior of individuals, households, and organizations (called
economic actors, players, or agents), when they manage or use scarce resources, which have

26
alternative uses, to achieve desired ends. Agents are assumed to act rationally, have multiple
desirable ends in sight, limited resources to obtain these ends, a set of stable preferences, a
definite overall guiding objective, and the capability of making a choice. There exists an
economic problem, subject to study by economic science, when a decision (choice) is made by
one or more resource-controlling players to attain the best possible outcome under bounded
rational conditions. In other words, resource-controlling agents maximize value subject to the
constraints imposed by the information the agents have, their cognitive limitations, and the
finite amount of time they have to make and execute a decision. Economic science centers on
the activities of the economic agents that comprise society. They are the focus of economic
analysis.
An approach to understanding these processes, through the study of agent behavior under
scarcity, may go as follows:
The continuous interplay (exchange or trade) done by economic actors in all markets sets the
prices for all goods and services which, in turn, make the rational managing of scarce resources
possible. At the same time, the decisions (choices) made by the same actors, while they are
pursuing their own interest, determine the level of output (production), consumption, savings,
and investment, in an economy, as well as the remuneration (distribution) paid to the owners of
labor (in the form of wages), capital (in the form of profits) and land (in the form of rent). Each
period, as if they were in a giant feedback system, economic players influence the pricing
processes and the economy, and are in turn influenced by them until a steady state
(equilibrium) of all variables involved is reached or until an external shock throws the system
toward a new equilibrium point. Because of the autonomous actions of rational interacting
agents, the economy is a complex adaptive system.
Keynesian Economics
Keynesian economics derives from John Maynard Keynes, in particular his book The General
Theory of Employment, Interest and Money (1936), which ushered in contemporary
macroeconomics as a distinct field. The book focused on determinants of national income in the
short run when prices are relatively inflexible. Keynes attempted to explain in broad theoretical
detail why high labour-market unemployment might not be self-correcting due to low "effective
demand" and why even price flexibility and monetary policy might be unavailing. The term
"revolutionary" has been applied to the book in its impact on economic analysis.
Keynesian economics has two successors. Post-Keynesian economics also concentrates on

macroeconomic rigidities and adjustment processes. Research on micro foundations for their

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models is represented as based on real-life practices rather than simple optimizing models. It is
generally associated with the University of Cambridge and the work of Joan Robinson.
New-Keynesian economics is also associated with developments in the Keynesian fashion. Within
this group researchers tend to share with other economists the emphasis on models employing
micro foundations and optimizing behavior but with a narrower focus on standard Keynesian
themes such as price and wage rigidity. These are usually made to be endogenous features of
the models, rather than simply assumed as in older Keynesian-style ones.
Chicago School of Economics
The Chicago School of economics is best known for its free market advocacy and monetarist
ideas. According to Milton Friedman and monetarists, market economies are inherently stable if
the money supply does not greatly expand or contract. Ben Bernanke, former Chairman of the
Federal Reserve, is among the economists today generally accepting Friedman's analysis of the
causes of the Great Depression.
Milton Friedman effectively took many of the basic principles set forth by Adam Smith and the
classical economists and modernized them. One example of this is his article in the September
1970 issue of The New York Times Magazine, where he claims that the social responsibility of
business should be "to use its resources and engage in activities designed to increase its profits
... (through) open and free competition without deception or fraud."
General Criticisms
"The dismal science" is a derogatory alternative name for economics devised by the Victorian
historian Thomas Carlyle in the 19th century. It is often stated that Carlyle gave economics the
nickname "the dismal science" as a response to the late 18th century writings of The Reverend
Thomas Robert Malthus, who grimly predicted that starvation would result, as projected
population growth exceeded the rate of increase in the food supply. However, the actual phrase
was coined by Carlyle in the context of a debate with John Stuart Mill on slavery, in which
Carlyle argued for slavery, while Mill opposed it.
Some economists, like John Stuart Mill or Léon Walras, have maintained that the production of
wealth should not be tied to its distribution.
In The Wealth of Nations, Adam Smith addressed many issues that are currently also the subject
of debate and dispute. Smith repeatedly attacks groups of politically aligned individuals who
attempt to use their collective influence to manipulate a government into doing their bidding.

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In Smith's day, these were referred to as factions, but are now more commonly called special
interests, a term which can comprise international bankers, corporate conglomerations, outright
oligopolies, monopolies, trade unions and other groups.
Economics per se, as a social science, is independent of the political acts of any government or
other decision-making organization, however, many policymakers or individuals holding highly
ranked positions that can influence other people's lives are known for arbitrarily using a
plethora of economic concepts and rhetoric as vehicles to legitimize agendas and value systems,
and do not limit their remarks to matters relevant to their responsibilities. The close relation of
economic theory and practice with politics is a focus of contention that may shade or distort
the most unpretentious original tenets of economics, and is often confused with specific social
agendas and value systems.
Notwithstanding, economics legitimately has a role in informing government policy. It is,

indeed, in some ways an outgrowth of the older field of political economy. Some academic
economic journals are currently focusing increased efforts on gauging the consensus of
economists regarding certain policy issues in hopes of effecting a more informed political
environment. Currently, there exists a low approval rate from professional economists regarding
many public policies. Policy issues featured in a recent survey of AEA economists include trade
restrictions, social insurance for those put out of work by international competition, genetically
modified foods, curbside recycling, health insurance (several questions), medical malpractice,
barriers to entering the medical profession, organ donations, unhealthy foods, mortgage
deductions, taxing internet sales, Wal-Mart, casinos, ethanol subsidies, and inflation targeting.
In Steady State Economics 1977, Herman Daly argues that there exist logical inconsistencies
between the emphasis placed on economic growth and the limited availability of natural
resources.
Issues like central bank independence, central bank policies and rhetoric in central bank
governors discourse or the premises of macroeconomic policies (monetary and fiscal policy) of
the state, are focus of contention and criticism.
Deirdre McCloskey has argued that many empirical economic studies are poorly reported, and
she and Stephen Ziliak argue that although her critique has been well-received, practice has not
improved. This latter contention is controversial.
A 2002 International Monetary Fund study looked at "consensus forecasts" (the forecasts of
large groups of economists) that were made in advance of 60 different national recessions in the
1990s: in 97% of the cases the economists did not predict the contraction a year in advance. On

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those rare occasions when economists did successfully predict recessions, they significantly
underestimated their severity.
Criticisms of Assumptions
Economics has been subject to criticism that it relies on unrealistic, unverifiable, or highly
simplified assumptions, in some cases because these assumptions simplify the proofs of desired
conclusions. Examples of such assumptions include perfect information, profit maximization and
rational choices. The field of information economics includes both mathematical-economical
research and also behavioral economics, akin to studies in behavioral psychology.
Nevertheless, prominent mainstream economists such as Keynes and Joskow have observed that
much of economics is conceptual rather than quantitative, and difficult to model and formalize
quantitatively. In a discussion on oligopoly research, Paul Joskow pointed out in 1975 that in
practice, serious students of actual economies tended to use "informal models" based upon
qualitative factors specific to particular industries. Joskow had a strong feeling that the
important work in oligopoly was done through informal observations while formal models were
"trotted out ex post". He argued that formal models were largely not important in the empirical
work, either, and that the fundamental factor behind the theory of the firm, behavior, was
neglected.
In recent years, feminist critiques of neoclassical economic models gained prominence, leading
to the formation of feminist economics. Contrary to common conceptions of economics as a
positive and objective science, feminist economists call attention to the social construction of
economics and highlight the ways in which its models and methods reflect masculine
preferences. Primary criticisms focus on failures to account for: the selfish nature of actors
(homo economicus); exogenous tastes; the impossibility of utility comparisons; the exclusion of
unpaid work; and the exclusion of class and gender considerations. Feminist economics
developed to address these concerns, and the field now includes critical examinations of many
areas of economics including paid and unpaid work, economic epistemology and history,
globalization, household economics and the care economy. In 1988, Marilyn Waring published
the book If Women Counted, in which she argues that the discipline of economics ignores
women's unpaid work and the value of nature; according to Julie A. Nelson, If Women Counted
"showed exactly how the unpaid work traditionally done by women has been made invisible
within national accounting systems" and "issued a wake-up call to issues of ecological
sustainability." Bjørnholt and McKay argue that the financial crisis of 2007–08 and the response

30
to it revealed a crisis of ideas in mainstream economics and within the economics profession,
and call for a reshaping of both the economy, economic theory and the economics profession.
They argue that such a reshaping should include new advances within feminist economics that
take as their starting point the socially responsible, sensible and accountable subject in creating
an economy and economic theories that fully acknowledge care for each other as well as the
planet.
Philip Mirowski observes that
The imperatives of the orthodox research programme [of economic science] leave little room for
maneuver and less room for originality. ... These mandates ... Appropriate as many mathematical
techniques and metaphorical expressions from contemporary respectable science, primarily
physics as possible. ... Preserve to the maximum extent possible the attendant nineteenth-
century overtones of "natural order" ... Deny strenuously that neoclassical theory slavishly
imitates physics. ... Above all, prevent all rival research programmes from encroaching ... by
ridiculing all external attempts to appropriate twentieth century physics models. ... All
theorizing is [in this way] held hostage to nineteenth-century concepts of energy.
In a series of peer-reviewed journal and conference papers and books published over a period of
several decades, John McMurtry has provided extensive criticism of what he terms the
"unexamined assumptions and implications [of economics], and their consequent cost to people's
lives."
Nassim Nicholas Taleb and Michael Perelman are two additional scholars who criticized
conventional or mainstream economics. Taleb opposes most economic theorizing, which in his
view suffers acutely from the problem of overuse of Plato's Theory of Forms, and calls for
cancellation of the Nobel Memorial Prize in Economics, saying that the damage from economic
theories can be devastating. Michael Perelman provides extensive criticism of economics and its
assumptions in all his books (and especially his books published from 2000 to date), papers and
interviews.
Despite these concerns, mainstream graduate programs have become increasingly technical and
mathematical.

Economics Basics

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1

Reading Material for Basic Economics

Besides the traditional concern in production, distribution, and consumption in an economy,

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Microeconomicsexamines how entities, forming a market structure, interact within a market to

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Microeconomics studies individual markets by simplifying the economic system by assuming

Production, cost, and efficiency

In microeconomics, production is the conversion of inputs into outputs. It is an economic

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Specialization is considered key to economic efficiency based on theoretical and empirical

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Supply and demand

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Demand-and-supply analysis is used to explain the behavior of perfectly competitive markets,

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Managerial economics applies microeconomic analysis to specific decisions in business firms or

Uncertainty and Game Theory

Uncertainty in economics is an unknown prospect of gain or loss, whether quantifiable as risk

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In this, it generalizes maximization approaches developed to analyze market actors such as in

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government-mandated partial insurance, restructuring or bankruptcy law, inspection, and

Natural monopoly, or the overlapping concepts of "practical" and "technical" monopoly, is an

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Welfare economics is a normative branch of economics that uses microeconomic techniques to

The circulation of money in an economy in a macroeconomic model.

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The amount of unemployment in an economy is measured by the unemployment rate, the

Structural unemployment covers a variety of possible causes of unemployment including a

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International trade studies determinants of goods-and-services flows across international

Gross domestic product (GDP)

GDP is related to national accounts, a subject in macroeconomics. GDP is not to be confused

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Expositions of economic reasoning often use two-dimensional graphs to illustrate theoretical

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The professionalization of economics, reflected in the growth of graduate programs on the

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History of Economic Thought

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Classical Political Economy

Smith discusses potential benefits of specialization by division of labour, including increased

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In microeconomics, neoclassical economics represents incentives and costs as playing a

Neoclassical economics is occasionally referred as orthodox economics whether by its critics or

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Keynesian economics has two successors. Post-Keynesian economics also concentrates on

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Chicago School of Economics

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Notwithstanding, economics legitimately has a role in informing government policy. It is,

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Philip Mirowski observes that